Facebook Lock-Up: Levitating Shares Defy Empirical Evidence

On November 13th, a WSJ article "Facebook Short Sellers 'Losing Appetite' as Lockup Looms" reported that the borrowing in Facebook (NASDAQ:FB) "has dropped by almost 40% this month, and sits at the lowest level since June, according to SunGard Financial Systems' Astec Analytics unit." This implies a reduction to the short interest reported by NASDAQ at the end of October of 87,988,874 to approximately 55 million shares.

The next day, November 14th, the WSJ published "Facebook Shares Rocket Higher Despite Lockup Expiration" at 11:47 AM proclaiming that some were calling the FB share rise a "short squeeze." Wednesday was a big day for FB because of the much reported historically large lockup expiration. (FB SEC link 8K)

So what really happened? With the release of 777 million shares into the float for FB with high pre-market volume which continued into the open of trading, FB stock stabilized and actually traded up $2.50 on volume exceeding 200 million shares. This counterintuitive, non-logical phenomenon had many media outlets scrambling to find out what happened, especially given the backdrop of the market under pressure from fears of the "fiscal cliff," renewed European economic turmoil and Middle East tensions.

Many followers of FB stock, including us, have predicted heavy pressure on the name stemming from the lock-up expiration. After going through numerous articles on the puzzling share price rise, we highlight a sampling of purported reasons for FB's levitation:

We understand there is a lot of media attention to Facebook for many reasons. One of the biggest reasons in financial circles is the dramatic disparity between the IPO and current price of its stock. Our list above is but a sampling of reasons given for Wednesday's 12.5% rally in FB shares against the backdrop of one of the largest lock-up expiration of shares in history and the 47 point drop in the Nasdaq Composite.

It seems obvious to us that a concerted effort by Wall Street firms to counter the "tsunami" of shares coming into the float was needed to keep Facebook from hitting new lows. New supporters of the stock emerged that day with Cantor Fitzgerald and Topeka Capital Markets being quoted in the above referenced WSJ article. It is in the collective "street" interest to keep FB from falling on a well publicized heavy pressure day stemming from the increase in "float" shares.

In many ways, this could be characterized as FB's second coming out or IPO celebration. IPOs always need aftermarket support and that is what FB got in spades on Wednesday. What happened can be best described in the old adage "the best defense is a good offense." Facebook's advisors are among the most venerable household banking names in finance. We believe it was in their best interest to coordinate a FB share purchasing campaign. We know there is always a red flag when investors see insiders and employees selling shares. According to the Financial Times on lock-up agreements in general: "Empirical evidence shows that the expiration of the lock-up agreements is often associated with negative stock returns for the company's stock." It is therefore prudent to assume the Facebook underwriters warned potential selling shareholders of the risks from the immediate sale of their shares on November 14th in order to keep FB shares from falling based on this negative perception. Arguably unethical, we know this is part of the normal function of the "street" and is business as usual. We are sure that all security laws were followed given the high profile of Facebook. Sometimes these efforts work and sometimes they merely postpone the inevitable. We will soon see.

Logically, however, it's puzzling to many why anyone who wants to purchase shares in Facebook at the best possible price would step into the void of the largest share lock-up expiration in recent history and prop up FB's stock price. We stick to our belief that FB shares are overvalued with a fully diluted market-cap of over $63 billion. We believe that recent purchasers of FB may have underestimated the amount of buying power needed to support a 777 million share lock-up expiration in addition to other expirations. Ultimately, they will have to support the massive float of approximately 2.7 billion shares.

The reality is there are many sellers of FB stock who were just released from their lock-ups. Here is a list of individuals and the links to their Form 4 filings from 11/15 which gives us a peek on what's starting to unfold in this saga:

Our advice is to stand back and let the float of Facebook shares take its course and settle in on the stock price. We think the supporters are already getting a little tired propping up this security primarily to save "face." Even Henry Blodget isn't advising retail investors to buy at these prices. He does give his own reason for the huge volume propping up the stock in "Big Money Buying Facebook?"

In today's high velocity trading environment, the hedge fund and mutual fund purchases of FB as of 9/30/2012 are meaningless because they are neither timely nor significant in terms of size. These investors could have easily quickly profited from these shares and sold out of their reported positions.

Facebook has done its best to keep its story fresh by announcing FBX, an advertising trading exchange, a gifts program and most recently a new jobs application. Yet, the stock seems to be stuck in a rut. It has been in a narrow range from $17.55 to $24.25 since August 16.

We would like to give a "hat tip" to fellow SA contributor Serenity who wrote "A Complete Benjamin Graham Analysis For Facebook" which concluded that "Graham's recommended price for Facebook is the NCAV price, which works out to $3.93." We think that may be low in terms of target price, but it certainly gives one pause when looking at yesterday's closing price.

Disclosure: I am short FB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.